Download Lecture 4 - Cal Poly Pomona

EC 201
Cal Poly Pomona
Dr. Bresnock
Lecture 4
Market Analysis (cont.)
In the table below, several points will be made to review the material that was covered in the
last lecture. Then we will proceed to tabulate new information pertaining to our market
analysis.
Table 1 Market Analysis
(1)
(2)
(3)
(4)
(5)
100
11
40
90
10
50
80
9
60
70
8
70
60
7
80
50
6
90
40
5
100
30
4
110
(6)
(7)
EC 201
Dr. Bresnock
Lecture 4
Price Elasticity – measures the responsiveness of the % change in quantity demanded (QD) (or
quantity supplied (QS)) relative to a % change in price (P), of the same good.
Price Elasticity Formula – Let EP represent the price elasticity coefficient. P1 and P2
represent two different prices, and Q1 and Q2 represent the quantities associated with those
prices.
EP =
%Q
% P
(Note: If the quantity used in the numerator is QD, then this formula
will calculate the price elasticity of demand. If the quantity
used in the numerator is QS, then this formula will calculate
the price elasticity of supply.
Q2 - Q1
Q2 + Q1
2
EP =
P2 - P1
P2 + P1
2
Interpretation of Price Elasticity Coefficients
The use of percentage changes enables us to compare the consumer (or producer)
responsiveness to changes in the prices of different products. The absolute value of the
percentage change allows us to determine how elastic the consumer (or producer)
responsiveness is relative to the change in price.
Note: Price elasticities of demand will have a minus sign prior to conversion to absolute value
because of the inverse relationship between quantity demanded and price. Price elasticities of
supply will always be positive due to the direct relationship between quantity supplied and
price. Economists sometimes avoid use of the minus sign by giving the price elasticity of
demand as ED. Similarly the price elasticity of supply would be ES.
Some Examples
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EC 201
Dr. Bresnock
Lecture 4
3 Elasticity Cases
1)
Elastic – the percentage change in quantity demanded (or supplied) will exceed the
percentage change in price. That is, %  QD > %  P and EP  > 1
2)
Unit Elastic – the percentage change in quantity demanded (or supplied) is equal to the
percentage change in price. That is, %  QD = %  P and EP  = 1
3)
Inelastic – the percentage change in quantity demanded (or supplied) is less than the
percentage change in price. That is, %  QD < %  P and EP  < 1.
Elasticity Determinants
1) Substitutability – the greater the availability of substitute goods, the greater the
elasticity and vice versa. Depends how narrowly the product is defined, i.e. price
elasticity of motor oil <price elasticity of Shell Motor Oil
2) Proportion of Income – the higher the price of the good is relative to the consumer’s
income, the greater the elasticity and vice versa. Price elasticity of homes > price
elasticity for cappuccinos.
3) Degree of Need – price elasticity of luxuries is greater than that of necessities.
4) Time – over time adjustments are easier to make for a variety of reasons.
Graph 1: Elasticity Extremes -- Demand
Perfectly Elastic Demand
EP  = 
Ex.
(Compare with Relative Elasticity)
Perfectly Inelastic Demand
EP  = 0
Ex.
(Compare with Relative Inelasticity)
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EC 201
Dr. Bresnock
Lecture 4
Demand Price Elasticity and Total Revenue – for an ordinary D-Curve, there are 3 cases to
consider in the relationship between P and TR:
1)
Elastic Demand – when P falls and D is elastic, TR will rise and vice versa.
Ep  > 1
As P  , TR  and vice versa
2)
Unit Elastic Demand – when P falls or rises and D is unit elastic, TR will stay the
same.
Ep  = 1
As P  or , TR stays the same
3)
Inelastic Demand – when P falls and D is inelastic, TR will fall and vice versa
Ep  < 1
Graph 2
As P  , TR  and vice versa
Demand Price Elasticity and Total Revenue
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EC 201
Dr. Bresnock
Lecture 4
Graph 3: Elasticity Extremes – Supply
Time is the key determinant of supply price elasticity.
Perfectly Elastic Supply
EP  = 
Ex.
(Compare with Relative Elasticity)
Perfectly Inelastic Supply
EP  = 0
Ex.
(Compare with Relative Inelasticity)
Some Examples
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EC 201
Dr. Bresnock
Lecture 4
Income Elasticity – measures the responsiveness of the % change in quantity demanded (QD)
(or quantity supplied (QS)) relative to a % change in income (I). We will focus on the income
elasticity with respect to demand in our examples.
Income Elasticity Formula – Let EI represent the income elasticity coefficient. I1 and I2
represent two different incomes, and Q1 and Q2 represent the quantities demanded associated
with those incomes.
EI =
%Q
% I
(Note: If the quantity used in the numerator is QD, then this formula
will calculate the income elasticity of demand. If the quantity
used in the numerator is QS, then this formula will calculate
the income elasticity of supply.)
Q2 - Q1
Q2 + Q1
2
EI =
I2 - I1
I2 + I 1
2
Note: Income elasticities of demand will have a minus sign prior to conversion to absolute
value because of the inverse relationship between quantity demanded and income for some
goods. A negative sign on an income elasticity signifies that the good is an inferior good.
Income elasticities of demand will be positive due to the direct relationship between quantity
demanded and income for some goods. A positive sign on an income elasticity signifies that
the good is a normal good.
3 Elasticity Cases
1)
Elastic – the percentage change in quantity demanded (or supplied) will exceed the
percentage change in income. That is, %  QD > %  I and EI > 1
2)
Unit Elastic – the percentage change in quantity demanded (or supplied) is equal to the
percentage change in income. That is, %  QD = %  I and EI = 1
3)
Inelastic – the percentage change in quantity demanded (or supplied) is less than the
percentage change in income. That is, %  QD < %  I and EI  < 1.
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EC 201
Dr. Bresnock
Lecture 4
Graph 4: Income Elasticity Extreme – Neutral Goods
Perfectly Inelastic
EI  = 0
Ex.
Income Elasticity: Some Examples
Cross Price Elasticity – measures the responsiveness of the % change in quantity demanded
(QD) for one good relative to a % change in the price of another good
Cross Price Elasticity Formula – Let EX,Y represent the cross elasticity coefficient. Let P1Y
and P2Y represent two different prices of one good, and Q1X and Q2X represent the quantities
demanded of another good that are associated with those prices. Let X and Y represent two
different goods.
EX,Y =
%  QX
%  PY
(Note: Any letters or numbers may be used to denote the two
different goods.)
Q2 X - Q1 X
Q2 X + Q 1 X
2
EX,Y =
P2Y - P1Y
P2Y + P1Y
2
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EC 201
Dr. Bresnock
Lecture 4
Note: Cross elasticities of demand will have a minus sign prior to conversion to absolute value
because of the inverse relationship between the quantity demanded of one good and the price of
another good. A negative sign on a cross elasticity signifies that the goods are complementary
goods. Cross elasticities of demand will be positive due to the direct relationship between the
quantity demanded of one good and the price of another good. A positive sign on a cross
elasticity signifies that the goods are a substitutes.
Interpretation of Cross Price Elasticity Coefficients
The use of percentage changes enables us to compare the consumer’s responsiveness to
percentage changes in the quantity demand of one good relative to the percentage changes in
the price of another good. The absolute value of the percentage change allows us to determine
how elastic the consumer‘s responsiveness is when viewing the two different goods.
1)
Elastic – the percentage change in quantity demanded of one good will exceed the
percentage change in the price of another good. That is, %  QDX > %  PY and
EX,Y > 1
2)
Unit Elastic – the percentage change in quantity demanded of one good is equal to the
percentage change in the price of another good. That is, %  QDX = %  PY and
EX,Y = 1
3)
Inelastic – the percentage change in quantity demanded of one good is less than the
percentage change in the price of another good. That is, %  QDX < %  PY and
EX,Y  < 1.
Graph 5: Cross Price Elasticity Extreme – Independent/Unrelated Goods
Perfectly Inelastic
EX,Y  = 0
Ex.
Cross Price Elasticity: Some Examples
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EC 201
Dr. Bresnock
Lecture 4
Market Equilibrium Solution (Algebraic)
Let Demand be represented as:
QD = 300 – 3P
Let Supply be represented as:
QS = 100 + 2P
Remember that in equilibrium QD = QS. Solve for the equilibrium price and quantity below.
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